Under the accrual basis of accounting, the financial transactions are to be recorded as and when they occur. When the seller provides services or sells goods, then he has to recognize the revenue even if the customer has not made payment.
This is in line with the accrual concept. It is the revenue that the company earned after selling its goods or services although it hasn’t received its payment yet.
This recording of transactions is even mandated as per the Revenue recognition principle that defines when revenue is to be recorded. As per AS 9 on revenue recognition, revenue can be only recognized when these two conditions are fulfilled:
It is usually recorded as a current asset because the gap period between earning revenue and receipt of cash is usually less than a year or a working capital cycle. It is shown in the balance sheet as a current asset when the related revenue is shown in the income statement.
As the payments are received, the accrued revenue gets deducted by the amount of cash received, with no further effect on the income statement. A high accrued revenue signifies that the business is not receiving timely payments for its products or services and can be alarming for the financial health of the company.
The conditions required for booking the accrued revenue are as follows:
Situations when accrued revenue arises and needs to be booked:
Example of accrued revenue:
A sold goods to B on December 30, 2019, for Rs 5000. He closes the books of accounts on December 31. He received the payment on January 10, 2020. How should he record revenue?
On December 31, 2020, A should recognize the revenue of Rs 5000 after the conditions of revenue recognition have been duly met. Such conditions are
The journal entries to be passed are:
At the point of sales being made:
|To Sales revenue||5,000|
At the time of receipt of cash:
Accrued revenue is the revenue that has been recognized but not yet realized. It is also called unbilled revenue. It is recorded when there is a mismatch between the time of the payment and delivery of goods and services.
This can arise in the following cases:
Presentation of accrued revenue in financial statements:
Accrued revenue is shown as adjusting journal entries under the current assets category in the balance sheet and as an earned revenue in the income statement of the company. When the payment is cleared, it is recorded as an adjusting entry to the asset account for accrued revenue.
A bank grants a loan to a customer of Rs 500000 at 10% per annum on January 1, 2020. The amount will be collected after a period of 1 year. After the passage of 1 month, the bank is entitled to revenue of 1-month interest. Hence, the entry would be:
|Jan 31||Interest receivable A/C Dr||4,167|
|To Interest income A/C||4,167|
Interest receivable of Rs 4167 would be shown as a current asset in the balance sheet and as earned revenue in the P&L statement as per the accrual principle.
ABC IT services company agrees to build software for PQR company in 12 months for Rs. 400,000. According to the contract, ABC is expected to deliver the first milestone in 6 months which is valued at Rs. 250,000. A second milestone would be delivered at the end of the contract in another 6 months.
Hence ABC must record accrued revenue at the end of the first milestone. The entry would be:
|June 30||Accrued revenue A/C Dr||250,000|
|To Revenue A/C||250,000|
After the completion of the milestone and total bill being issued, ABC must record the following:
|Dec 31||Revenue A/C Dr||250,000|
|To Accrued revenue A/C||250,000|
|Dec 31||Accounts receivable A/C Dr||400,000|
|To Revenue A/C||400,000|
When cash is received, the entry is
|Dec 31||Cash A/C Dr||400,000|
|To Accounts receivable A/C||400,000|